Stemming Rupee Slide - India’s Growing Concern

Posted in Finance Articles, Total Reads: 2408
, Published on 04 June 2012

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The Indian rupee has been steadily weakening against Dollar & has already crossed the 56- level mark for the first time in last 5 months and is on a record breaking spree since then in spite of manifold RBI interventions. This is mainly because of the continued uncertainty about the political situation in Greece which headed for re – elections recently due to failure of formation of new government.

The uncertainty in the global downturn is driving the investors to shun the emerging markets & go for perceived safer destinations. This has hit hard countries like India which is facing the brunt caused by weakening demand of exports, widening Current Account Deficit & Fiscal Deficit.

Rupee has lost around 10.21% of its value since July 2011 & is amongst the worst performing Asian currency. Not only International factors have contributed to depleting Rupee value. Instead the domestic factors have played significantly for Rupee’s downward slide. India's Current Account Deficit (CAD) & Fiscal Deficit has been a growing concern for the policy makers. CAD is currently 4% of GDP while Fiscal deficit is also expected to cross the budgeted level for current fiscal year of 4.6%. RBI has been intervening the market to offset the Rupee volatility. Forex Reserves have shrunk to $ 293 billion from as high as $ 320 billion.

In this economic mayhem, even the India’s growth prospects forecasts don’t seem rosy at all. According to latest World Bank’s report the current spell of economic slowdown is going to continue in the next financial year 2012-13. The GDP has expanded by 6.1% in Q4 of 2011-12 which is much below the average growth rate of more than 7% in the decade since 1997 primarily due to deceleration in industrial growth.

Our Imports have been rising at a fast clip with both Oil & Gold contributing to widening CAD where oil alone contributing to one third of the imports. Standard and Poor’s (S&P) cut India’s rating outlook to negative from stable, citing the slow pace of fiscal consolidation, the worsening external sector situation, sluggish pace of economic growth and inflationary pressures.

The increasing rifts between Business Firms & the Indian Government would impact the investor sentiments. The latest being Vodafone Tax controversy & mounting mistrust between Reliance Industries & government over D6 Block decreasing output. The government continues to maintain a stern posture towards both the companies which has tarnished India’s image as an investment friendly nation. Adding to that the recent hue & cry over not allowing FDI in multi-brand retail, TRAI’s recommendations on spectrum’s auction being severely criticized by the Telecom Companies has posed questions whether these structural reforms would actually help India gain Investors confidence?

Since India has very limited role to play in the impact of Euro-zone Crisis so in order to arrest the downward spiral, the Policymakers need to address the domestic factors. The Current Account Deficit can be significantly reduced by aligning the domestic fuel prices to the International prices. The market is expecting the RBI to announce a direct dollar window for oil companies, similar to one they did in 2008. This would control Rupee because oil companies will be coming directly to RBI for supplying dollars to them.

Whenever the oil companies buy dollars from the market, there is always spill over effect in the market which will not be the case in case RBI opens up separate window for the oil companies. In the meanwhile, the Government should review the subsidy regimes. Currently the Indian government cushions the Oils prices by providing subsidies. Though reducing the subsidy would pass on the costs to the consumers & increase Inflation in short run, but it would reduce the demand for Petrol & Diesel and force the consumers to use fuel more efficiently. This would contract the GDP initially but would later head towards more sustainable growth.

The next step should be to discourage the Gold imports. Over the last few years Gold prices have more than doubled because of increase in demand due to the lack of reliable investments opportunities. More & more people are investing in Gold or Gold ETFs because they consider it to be a very save investment instrument. Therefore better investment opportunities should be promoted like Inflation Indexed Bonds etc. The investment climate should be improvised so as to restore investor’s confidence into ventures other than Gold.

In short term RBI has already structured series of steps to attract dollars like deregulation of interest rates on Non Resident Ordinary (NRO) savings accounts and Non Resident External (NRE) term deposits, freeing up interest rates on the Foreign Currency Non Resident (FCNR) Account. It can also raise the limit on G-Sec holdings by FIIs or loosen the restrictions on bond holdings by FIIs. However this should also be supported from the Fiscal side as well. The Government should formulate structural measures such as expediting FDI reforms in areas like Retail, Insurance & Aviation, introduce Goods & Services (GST) Tax to the earliest.

GST would replace existing levies such as excise duty, service tax and value-added tax (VAT). Eliminating a multiplicity of existing indirect taxes will simplify the tax structure, broaden the tax base, and create a common market across states. The GST will not cover goods like crude oil, diesel, petrol and alcohol. These goods are major sources of revenues for most states. However, States are worried they will lose their fiscal autonomy if they cannot impose taxes on their own. Any delay in implementation of GST would transfer the taxes to be exported which can’t be recovered. The biggest benefit of GST is that it would cut business cost & enhance export competitiveness in International Markets.

Finance Minister Pranab Mukherjee recently introduced Finance Bills 2012 to give boost to the slowing economy. GAAR has been deferred for a year to provide more time to both taxpayers and the tax administration to address all issues relating to the system. The GAAR threatens to have serious effects upon companies that have invested in India or have plans to do so. Unfortunately, GAAR Provisions have adversely affected the outlook and confidence of foreign investors in India at a time when India is actively seeking increased levels of foreign direct investment. The need of the hour for the Government is to introduce prudent structural reforms which synergies well with the efforts of RBI and gives desired impetus to an already ailing Indian Economy.

This has been indicated by the Finance Minister as he has assured that the Government would very soon come up with austerity measures to combat pressure & stem depreciating Rupee. It is expected that the austerity measures would focus primarily on cutting the imports, creating new avenues of investments, minimizing subsidy on Oil, curbing Gold imports and reforms to attract FDI investors. But the biggest challenge in front of the policymakers is whether these measures would stem falling Rupee or not. In an environment of premonitions it’s too early to predict these reforms and its effect on value of Rupee & only time is going to answer that.

In this economic
mayhem, even the India’s growth prospects forecasts don’t seem rosy at all.
According to latest World Bank’s report the current spell of economic slowdown is going to continue
in the next financial year 2012-13. The GDP has expanded by 6.1% in Q4 of
2011-12 which is much below the average growth rate of more than 7% in the
decade since 1997 primarily due to deceleration in industrial growth. Our
Imports have been rising at a fast clip with both Oil & Gold contributing
to widening CAD where oil alone contributing to one third of the imports.
Standard and Poor’s (S&P) cut India’s rating outlook to negative from
stable, citing the slow pace of fiscal consolidation, the worsening external
sector situation, sluggish pace of economic growth and inflationary pressures.

The increasing rifts between Business Firms & the Indian Government
would impact the investor sentiments. The latest being Vodafone Tax controversy
& mounting mistrust between Reliance Industries & government over D6 Block
decreasing output. The government continues to maintain a stern posture towards
both the companies which has tarnished India’s image as an investment friendly
nation. Adding to that the recent hue & cry over not allowing FDI in
multi-brand retail, TRAI’s recommendations on spectrum’s auction being severely
criticized by the Telecom Companies has posed questions whether these
structural reforms would actually help India gain Investors confidence?